Bankruptcy sales for distressed hospitals: 4 questions to ask before you begin

by DLA Piper

Over the last several years, a wide range of healthcare companies, among them hospitals, home health agencies and continuing care facilities, have faced financial distress as a result of declining revenues, high operating costs, reduction in reimbursements rates and increasing competition.  Seeking relief, many hospitals and other healthcare companies are commencing chapter 11 cases and selling their assets to third parties in order to shed liabilities and facilitate an orderly transfer of their assets.  Fairmont General Hospital, Saint Francis Hospital, Natchez Regional Medical Center and Sound Shore Medical Center are just a few of the hospitals that have recently filed for bankruptcy, selling (or are seeking to sell) all or a portion of their assets to third parties.    

In addition to yielding substantial benefits for distressed hospitals, bankruptcy sales also present unique opportunities for third parties to acquire valuable assets at a discount, free from claims arising from their financial distress.  In general, the sale of assets in a corporate chapter 11 case is straightforward.  Section 363 of the Bankruptcy Code permits companies to sell all or substantially all of their assets free and clear of any interest in such assets to the bidder presenting the highest and best offer. 

However, when applied in the context of the heavily regulated healthcare industry, several additional considerations come into play.  The questions discussed below are just some of the myriad issues that can arise in the sale of hospitals in a bankruptcy proceeding.

1.  Do you have a potential strategic partner?

It is advisable for hospitals entering chapter 11 for the purpose of effectuating a sale or other transaction to have a potential strategic partner lined up at the time of filing.  This will provide much needed certainty for not only the hospitals, but also patients, residents, physicians, employees and suppliers.  While the initial offer from the strategic partner (the “stalking horse”) will be subject to higher and better offers, the relevant constituents will know that there is at least one resolution in hand.  In addition, having a “stalking horse” agreement in place will provide a starting point for negotiations with other potential purchasers.  

Once they are engaged in the sale process, parties should be made aware that purchase price is not the sole factor taken into consideration in determining what constitutes the highest and best offer for a debtor’s assets.  Other factors that should be considered include, but are not limited to, the purchaser’s ability to close the sale transaction in a timely manner, the purchaser’s commitment to preserving jobs and ongoing business relationships with suppliers and vendors post-sale, the purchaser’s ability to obtain required regulatory approvals, licenses, permits, accreditations and certifications needed to operate the business after the sale and, in the case of not-for-profit hospitals, the purchaser’s commitment to continuing the debtor’s charitable mission. 

Antitrust concerns were at issue in the bankruptcy case of Saint Francis Hospital, a 333-bed hospital in Poughkeepsie, New York which filed for chapter 11 in December 2013.  Saint Francis initially had a proposed deal in place with Health Quest as the stalking horse bidder.  Ultimately, however, Saint Francis decided to consummate a sale transaction with an affiliate of Westchester Medical Center, a 643-bed hospital in Valhalla, New York, due to, among other things, regulatory hurdles associated with Health Quest’s bid regarding whether the transaction with Health Quest would violate federal and state antitrust laws, including the Hart-Scott-Rodino Act.

 2. How will the sale affect patients?

Particularly in the sale of hospitals, courts will consider how the proposed sale will affect patients prior to approving the sale.  Both debtors and bankruptcy courts will want assurance from the proposed purchaser that, after the sale, the purchaser will continue to provide quality care and accommodations for patients. 

Indeed, the importance of maintaining patient care is highlighted by Congress’s enactment of section 333 of the Bankruptcy Code, which provides for the appointment of a patient care ombudsman for debtors in a healthcare business to monitor the quality of patient care and to represent the interests of patients during the debtor’s bankruptcy case. 

3. Are you maintaining patient medical record confidentiality?

Parties will also need to maintain the privacy of confidential patient medical records in accordance with applicable law, including the Health Insurance Portability and Accountability Act (HIPAA).  In the event all medical records are not transferred to the purchaser, the seller will need to make sure a protocol is in place for the retention and eventual disposal of such records in accordance with HIPAA.

4. What about successor liability?

Section 363(f) of the Bankruptcy Code generally provides that purchasers acquire assets in a sale free and clear of any “interest” in those assets, thereby forcing parties with pre-petition claims against a debtor to satisfy their claims from sale proceeds and not against the purchaser.  The Bankruptcy Code permits “free and clear sales” in order to encourage higher bids for estate assets and to promote an equitable distribution to creditors.  Certain post-petition claims may be barred by a section 363 sale order as well.  For example, the US Bankruptcy Court for the District of New Jersey recently ruled that certain economic tort and unfair competition claims against the purchaser of Christ Hospital relating to the purchase of the hospital were “interests” under section 363(f) of the Bankruptcy Code and, thus, the sale was free and clear of such claims.  In addition, the US Bankruptcy Court for the Southern District of New York recently ruled that the sale of Sound Shore Medical Center’s assets to Montefiore Medical Center was free and clear of the seller’s collective bargaining agreements.  Also, post-sale, the bankruptcy court established certain mediation procedures for medical malpractice claims against Sound Shore, which were excluded liabilities under the sale.     

Courts have found, however, that certain pre-petition claims against the debtor survive the sale process.  In particular, several courts have found that a purchaser that assumes a hospital’s Medicare provider number and related agreements acquires those assets subject to the government’s right to seek recoupment of overpayments made to the debtor prior to the bankruptcy filing.  Provider agreements under this line of cases are treated as continuing executory contracts and purchasers are deemed to assume both the benefits and burdens of those agreements.  Purchasers may also face successor liability for claims that extend beyond Medicare recoupment, including environmental claims previously asserted against the debtor or claims in favor of holders that were not properly noticed of the sale.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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